Rupee Settlement Mechanism

Q What is the context  ?

A India’s rupee trade settlement mechanism, a means of using rupees instead of dollars and other big currencies for international transactions, is attracting interest from more countries.

Q Which  countries are interested in India’s rupee settlement mechanism? 

A 

• Tajikistan, Cuba, Luxembourg and Sudan have begun talking to India about using the mechanism.
• They have shown interest in opening special rupee accounts, called vostro accounts.
• Opening of these accounts needs approval from the Reserve Bank of India.
• It has already been used by Russia following the imposition of sanctions on Moscow over the Ukraine war.

Q How does Rupee Settlement System for International Trade works ? 

A 

• Banks acting as authorized dealers for such transactions would have to take prior approval from the regulator to facilitate this.
• All exports and imports under the invoicing arrangement may be denominated and invoiced in Rupee.
• The exchange rate between the currencies of the two trading partner countries may be market determined.
• Exporters and importers can now use a Special Vostro Account linked to the correspondent bank of the partner country for receipts and payments denominated in rupees.
• These accounts can be used for payments for projects and investments, import or export advance flow management, and investment in Treasury Bills subject to Foreign Exchange Management Act, 1999 (FEMA).
• Also, the bank guarantee, setting-off export receivables, advance against exports, use of surplus balance, approval process, documentation, etc., related aspects would be covered under FEMA rules.

Q What are Benefits of such a mechanism ?

A 

• Trade facilitation: This will also facilitate trade with countries like Russia which are facing sanctions.
• FOREX savings: India imports more than it exports so the country will also save foreign currency under the new arrangement.
• Rupee appreciation: The rupee is at a historic low against the dollar. It will also help stabilize rupee.
• Mitigating war impact: Payments had become a pain point for exporters immediately after the Russia-Ukraine war broke out, especially after Russia was cut off from the SWIFT payment gateway.
• Convertibility easing: We see this as a first step towards 100% convertibility of rupee.
• Energy security: It will also help buy discounted crude oil from Russia, which now accounts for 10% of all imported crude.
• Export promotion: As such, the new mechanism will help India promote its exports.

Q Which countries would prefer this system?

A 

• War mongering Russia: For now, it looks like trade settlements in rupee will be limited to countries like Russia and Iran who are facing sanctions from the West
• Bankrupt Sri Lanka: SL is going through economic turmoil and India has been consistently extending lines of credit to SL.
• Immediate neighbors: Other countries may include immediate neighbors of India.

Q Rupees over Dollars: Why countries would prefer Rupees?

A 

• At a very simplistic level, this is like two Indians deciding to use an alternative mode of exchange that they have come up with, instead of using rupees.
• In other terms, this is similar to the barter system.
• The main reason for countries to want to trade with India in rupees is this:

1. USD has been going through a phase of strength against most currencies in the world
2. Strong USD performance has essentially made imports expensive for most countries
3. Sri Lanka, which is going through one of its worst economic crises in decades, is a glaring example of a country in which the economy has come to a halt due to a drastic fall in forex reserves

• While the Sri Lankan Rupee has declined over 83 percent against the US Dollar, its fall against the Indian Rupee has been lower at 70 percent.
• So instead of paying 83 percent more to make purchases in USD, Sri Lanka can pay in Indian Rupees and save some money.

Q What are the Challenges ?

A 

• Trade surplus countries’ preference: The question that RBI and the Indian government will have to answer is this – why would countries with a trade surplus with India want to trade in rupees?
• Negative trade balance: China had a $73-billion trade surplus with India in 2021-22 – that is, Indian imports from China exceeded its exports to China by $73 billion.
• Idle money lying useless: If China were to trade with India in rupees, it would have Indian rupees worth $73 billion (about ₹5.77 lakh crore) sitting idle in its Rupee Vostro accounts in an Indian bank.
• Few countries interested: Countries whose exports to India are more than imports, will not be too enthusiastic to trade in rupees, especially if the difference is huge as in the case of China.